$626B in CRE Debt Maturing in the Next Two Years is Potentially Troubled

A somber portrait of the state of U.S. capital markets and their impact on CRE emerges from Newmark’s second quarter Capital Report. It depicts a landscape of low loan originations, fewer lenders, underwater loans, troubled debt about to mature, and rising cap rates across a wide swath of the CRE spectrum.

Loans are hard to get in this new world. CRE debt origination is down 52% in 1H 2023 compared to the prior year and 31% compared to before the pandemic. Equally concerning, there are 32% fewer active lenders in the market today compared to a year ago. “The small and regional bank lending engine that has driven the CRE market is rapidly slowing with no clear replacement,” the report noted. 

And this is affecting the entire banking industry, not just regional banks. All property types and lending sectors are affected, “though office, debt funds and CMBS/CRE CLOs (commercial real estate collateralized loan obligations) are negative outliers.” Loan originations are down most dramatically for multifamily.

Furthermore, banks are being more restrictive about whom they lend to and the assets they are willing to consider.

And if loans are hard to get, some of those that were made in the good times and are coming due will create new headaches. Newmark predicts that $1.4 trillion in debt will mature in 2023-2025 — but with significantly higher debt costs than when the loans were originated. On top of that, many loans are actually or nearly underwater, especially recently issued property and office debt.

“We estimate that $626 billion in debt maturing in 2023-2025 is potentially troubled,” the report states.

Investors’ appetite for acquisitions has also diminished. Sales plummeted 62% year-over-year in 1H 2023, and 12% in 2Q 2023 compared to the first quarter. This trend applied in both 2Q 2023 and the first half. A slight uptick for multifamily, office and industrial sales was not strong enough to suggest a trend. 

“Investment has declined across capital groups, but institutional investors and REITs have declined most dramatically – likely due to higher sensitivity to cost of capital,” Newmark noted. In addition, investment sales fell in all regions in 1H 2023, while foreign investors also reduced their activity.

Yet, while lending and investment have largely pulled back, Newmark pointed out that there is capital on the sidelines. “Dry powder at closed-end funds currently sits at a record $261 billion, it noted – up 11% since January 2023. “The capital is concentrated in opportunistic and value-add vehicles, while debt strategies have pulled back. We estimate that 75% of this capital is targeting residential and industrial assets.”

“Longer term, a smaller bank role offers opportunities for private capital,” the report noted.

While new fundraising at close-end funds increased rapidly in 2Q 2023, it slowed to a halt in the REIT sector. “Nontraded REITS have been forced to limit redemptions, even as they’ve had success in bringing in new institutional partners and post surprisingly high returns,” Newmark noted. In addition, contributions to ODCE (Open End Diversified Core Equity) funds slumped.

The report also identified clear increases in transaction cap rates, “which now appear distinctly unattractive relative to the cost of debt capital, possibly excepting office REITs.”